SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-Q
Quarterly Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the Quarterly Period Ended Commission File
September 30, 1996 No. 1-11632
AMERICAN ANNUITY GROUP, INC.
Incorporated under IRS Employer I.D.
the Laws of Delaware No. 06-1356481
250 East Fifth Street, Cincinnati, Ohio 45202
(513) 333-5300
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act
of 1934 during the preceding 12 months, and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
As of November 1, 1996, there were 43,081,464 shares of the Registrant's
Common Stock outstanding.
Page 1 of 19
AMERICAN ANNUITY GROUP, INC. 10-Q
PART I
FINANCIAL INFORMATION
AMERICAN ANNUITY GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
(Dollars in millions)
September 30,December 31,
1996 1995
ASSETS
Investments:
Fixed maturities:
Held to maturity - at amortized cost
(market - $2,524.1 and $2,600.0) $2,521.4 $2,497.2
Available for sale - at market
(amortized cost - $3,133.1 and $2,787.6) 3,156.7 2,926.6
Equity securities - at market (cost - $13.2
and $14.1) 42.0 32.6
Investment in affiliate 21.1 20.3
Mortgage loans on real estate 71.5 70.4
Real estate 37.1 39.9
Policy loans 247.2 241.4
Short-term investments 30.0 140.7
Total investments 6,127.0 5,969.1
Cash 27.1 28.7
Accrued investment income 97.0 87.4
Unamortized insurance acquisition costs, net 182.3 149.8
Other assets 160.2 137.5
Assets held in separate accounts 243.3 238.5
Total assets $6,836.9 $6,611.0
LIABILITIES AND STOCKHOLDERS' EQUITY
Annuity benefits accumulated $5,279.2 $5,052.0
Life, accident and health reserves 561.1 538.3
Notes payable 159.5 167.7
Payable to affiliates, net 29.1 29.1
Deferred taxes on unrealized gains 17.0 48.0
Accounts payable, accrued expenses and other
liabilities 134.7 108.1
Liabilities related to separate accounts 243.3 238.5
Total liabilities 6,423.9 6,181.7
Series B Preferred Stock (at redemption value) 17.0 17.0
Common Stock, $1 par value
-100,000,000 shares authorized
- 43,077,301 and 43,071,882 shares outstanding 43.1 43.1
Capital surplus 360.5 361.1
Accumulated deficit at December 31, 1992 (212.6) (212.6)
Retained earnings since January 1, 1993 173.5 131.4
Unrealized gain on marketable securities, net of
deferred income taxes and insurance adjustments 31.5 89.3
Total stockholders' equity 413.0 429.3
Total liabilities and stockholders' equity $6,836.9 $6,611.0
2
AMERICAN ANNUITY GROUP, INC. 10-Q
AMERICAN ANNUITY GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED INCOME STATEMENT
(In millions, except per share amounts)
Three Nine
months ended months ended
September 30, September 30,
1996 1995 1996 1995
Revenues:
Net investment income $119.4 $102.3 $347.0 $297.1
Realized gains on sales of
investments 0.5 6.9 1.4 7.0
Life, accident and health premiums 24.8 0.4 80.3 1.6
Equity in net earnings (losses) of
affiliate (0.6) (0.7) 2.2 2.2
Other income 1.8 0.5 4.9 1.3
145.9 109.4 435.8 309.2
Costs and Expenses:
Annuity benefits 69.5 65.7 206.3 194.2
Life, accident and health benefits 21.7 0.2 70.2 1.3
Amortization of insurance acquisition
costs 6.9 2.6 21.1 6.2
Interest and other debt expenses 3.4 4.3 11.4 13.4
Other expenses 18.9 11.0 53.3 32.1
120.4 83.8 362.3 247.2
Income before taxes and
extraordinary item 25.5 25.6 73.5 62.0
Provision for income taxes 8.4 9.0 25.4 21.8
Income before extraordinary item 17.1 16.6 48.1 40.2
Extraordinary item - loss on
prepayment of debt (1.7) - (6.0) -
Net Income $15.4 $16.6 $42.1 $40.2
Preferred dividend requirement 0.4 - 1.1 -
Net income applicable to Common Stock $15.0 $16.6 $41.0 $40.2
Average common shares outstanding 43.1 40.8 43.1 39.7
Earnings (loss) per common share:
Continuing operations $0.39 $0.41 $1.09 $1.01
Extraordinary item (0.04) - (0.14) -
Net income $0.35 $0.41 $0.95 $1.01
3
AMERICAN ANNUITY GROUP, INC. 10-Q
AMERICAN ANNUITY GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
(In millions)
Nine months ended
September 30,
1996 1995
Preferred Stock:
Balance at beginning and end of period $ 17.0 $ -
Common Stock:
Balance at beginning of period $ 43.1 $ 39.1
Issued during the period - 4.0
Balance at end of period $ 43.1 $ 43.1
Capital Surplus:
Balance at beginning of period $361.1 $330.8
Common Stock issuance 0.1 33.3
Preferred dividends declared (0.7) -
Balance at end of period $360.5 $364.1
Accumulated Deficit at December 31, 1992: ($212.6) ($212.6)
Retained Earnings Since January 1, 1993:
Retained earnings from January 1, 1993 to
beginning of period $131.4 $ 76.1
Net income 42.1 40.2
Balance at end of period $173.5 $116.3
Unrealized Gains (Losses), Net:
Balance at beginning of period $ 89.3 ($ 29.0)
Change during period (57.8) 68.4
Balance at end of period $ 31.5 $ 39.4
4
AMERICAN ANNUITY GROUP, INC. 10-Q
AMERICAN ANNUITY GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
(In millions)
Nine months ended
September 30,
1996 1995
Cash Flows from Operating Activities:
Net income $ 42.1 $ 40.2
Adjustments:
Extraordinary losses on retirement of debt 6.0 -
Increase (decrease) in life, accident and
health reserves 22.8 (0.1)
Benefits to annuity policyholders 206.3 194.2
Amortization of insurance acquisition costs 21.1 6.2
Equity in net earnings of affiliate (2.2) (2.2)
Depreciation and amortization 3.9 2.4
Realized gains on investing activities (1.4) (7.0)
Increase in accrued investment income (9.6) (9.1)
Increase in insurance acquisition costs (46.9) (24.8)
Increase in other assets (4.4) (1.5)
Increase (decrease) in other liabilities (4.8) 8.4
Other, net (5.3) 1.3
227.6 208.0
Cash Flows from Investing Activities:
Purchases of and additional investments in:
Fixed maturity investments (759.4) (743.5)
Real estate, mortgage loans and other assets (21.7) (15.7)
Maturities and redemptions of fixed maturity
investments 195.1 106.5
Sales of:
Fixed maturity investments 207.9 407.7
Equity securities 1.2 1.6
Real estate, mortgage loans and other assets 21.1 5.2
Increase in policy loans (5.8) (16.9)
(361.6) (255.1)
Cash Flows from Financing Activities:
Annuity receipts 410.2 338.3
Annuity surrenders, benefits and withdrawals (372.0) (302.5)
Additions to notes payable 82.2 13.0
Reductions of notes payable (98.1) (46.4)
Issuance of common stock 0.1 37.3
Cash dividends paid (0.7) -
21.7 39.7
Net decrease in cash and short-term investments (112.3) (7.4)
Cash and short-term investments at beginning
of period 169.4 62.7
Cash and short-term investments at end of period $ 57.1 $ 55.3
5
AMERICAN ANNUITY GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A. Description of the Company
American Annuity Group, Inc. ("AAG" or "the Company") markets (i)
individual and group annuities nationwide to the savings and retirement
markets, (ii) individual life insurance and annuity policies with the
sponsorship of state associations of funeral directors as well as
individual funeral directors across the country, and (iii) various forms
of life, accident and health insurance and annuities through payroll
deduction plans and financial institutions.
AAG's parent, American Financial Corporation ("AFC"), was acquired by
American Financial Group, Inc. ("AFG") in April 1995. AFG and its
subsidiaries owned 35,059,995 shares (81%) of AAG's Common Stock at
November 1, 1996.
B. Accounting Policies
Basis of Presentation The accompanying consolidated financial
statements for AAG and its subsidiaries are unaudited, but management
believes that all adjustments (consisting only of normal recurring
accruals unless otherwise disclosed herein) necessary for fair
presentation have been made. The results of operations for interim
periods are not necessarily indicative of results to be expected for the
year. The financial statements have been prepared in accordance with
the instructions to Form 10-Q and therefore do not include all
information and footnotes necessary to be in conformity with generally
accepted accounting principles. Certain reclassifications have been
made to prior periods to conform to the current year's presentation.
The preparation of the financial statements requires management to make
estimates and assumptions that affect the amounts reported in the
financial statements and accompanying notes. Changes in circumstances
could cause actual results to differ materially from those estimates.
AAG's acquisition of Laurentian Capital Corporation ("LCC") in November
1995 was recorded as a purchase. The results of LCC's operations have
been included in AAG's consolidated financial statements since its
acquisition.
Investments Debt securities are classified as "held to maturity" and
reported at amortized cost if AAG has the positive intent and ability to
hold them to maturity. Debt and equity securities are classified as
"available for sale" and reported at fair value with unrealized gains
and losses reported as a separate component of stockholders' equity if
the securities are not classified as held to maturity or bought and held
principally for selling in the near term. Only in certain limited
circumstances, such as significant issuer credit deterioration or if
required by insurance or other regulators, may a company change its
intent to hold a certain security to maturity without calling into
question its intent to hold other debt securities to maturity in the
future.
Short-term investments are carried at cost; mortgage loans on real
estate are generally carried at amortized cost; policy loans are stated
at the aggregate unpaid balance.
Gains or losses on sales of securities are recognized at the time of
disposition with the amount of gain or loss determined on the specific
identification basis. When a decline in the value of a specific
investment is considered to be other than temporary, a provision for
impairment is charged to earnings and the carrying value of that
6
AMERICAN ANNUITY GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
investment is reduced. Premiums and discounts on mortgage-backed
securities are amortized over their expected average lives using the
interest method.
Investment in Affiliate AAG's investments in equity securities of
companies that are 20% to 50% owned by AFG and its subsidiaries are
carried at cost, adjusted for a proportionate share of their
undistributed earnings or losses.
Insurance Acquisition Costs Unamortized insurance acquisition costs
consist primarily of deferred policy acquisition costs and the present
value of future profits of acquired companies. Amortization of life
insurance acquisition costs includes first year commissions to the
extent they exceed those on annual renewals.
Deferred Policy Acquisition Costs ("DPAC") DPAC (principally
commissions, advertising, underwriting, policy issuance and sales
expenses that vary with and are primarily related to the production of
new business) is deferred to the extent that such costs are deemed
recoverable.
Deferred costs related to annuities and universal life insurance
products are amortized, with interest, in relation to the present value
of expected gross profits on the policies. These expected gross profits
consist principally of estimated future net investment income and
surrender, mortality and other policy charges, less estimated future
interest on policyholders' funds, policy administration expenses and
death benefits in excess of account values. DPAC is reported net of
unearned revenue relating to certain policy charges that represent
compensation for future services. These unearned revenues are
recognized as income using the same assumptions and factors used to
amortize DPAC.
Deferred costs related to traditional life and health insurance are
amortized over the expected premium paying period of the related
policies, in proportion to the ratio of annual premium revenues to total
anticipated premium revenues. Such anticipated premium revenues were
estimated using the same assumptions used for computing liabilities for
future policy benefits.
To the extent that realized gains and losses result in adjustments to
the amortization of DPAC, such adjustments are reflected as components
of realized gains.
To the extent that unrealized gains (losses) from securities classified
as "available for sale" would result in adjustments to DPAC, unearned
revenues and policyholder liabilities had those gains (losses) actually
been realized, such balance sheet amounts are adjusted, net of deferred
taxes.
Present Value of Future Profits Included in insurance acquisition costs
are amounts representing the present value of future profits on business
in force of the acquired insurance companies, which represent the
portion of the costs to acquire such companies that is allocated to the
value of the right to receive future cash flows from insurance contracts
existing at the date of acquisition. These amounts are amortized with
interest over the estimated remaining life of the acquired policies for
annuities and universal life products and over the expected premium
paying period for traditional life and health insurance products.
7
AMERICAN ANNUITY GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
Annuity Benefits Accumulated Annuity receipts and benefit payments are
generally recorded as increases or decreases in "annuity benefits
accumulated" rather than as revenue and expense. Increases in this
liability for interest credited are charged to expense and decreases for
surrender charges are credited to other income.
Life, Accident and Health Benefit Reserves Liabilities for future
policy benefits under traditional ordinary life, accident and health
policies are computed using the net level premium method. Computations
are based on anticipated investment yields, mortality, morbidity and
surrenders and include provisions for unfavorable deviations. Reserves
are modified as necessary to reflect actual experience and developing
trends.
The liability for future policy benefits for interest sensitive life
policies is equal to the sum of the accumulated fund balances under such
policies.
Assets Held In and Liabilities Related To Separate Accounts Investment
annuity deposits and related liabilities represent deposits maintained
by several banks under a previously offered tax-deferred annuity
program. The Company receives an annual fee from each bank for
sponsoring the program; if depositors elect to purchase an annuity from
the Company, funds are transferred to the Company.
Life, Accident and Health Premiums and Benefits For traditional life,
accident and health products, premiums are recognized as revenue when
legally collectible from policyholders. Policy reserves have been
established in a manner which allocates policy benefits and expenses on
a basis consistent with the recognition of related premiums and
generally results in the recognition of profits over the premium-paying
period of the policies.
For interest-sensitive life and universal life products, premiums are
recorded in a policyholder account which is reflected as a liability.
Revenue is recognized as amounts are assessed against the policyholder
account for mortality coverage and contract expenses. Surrender
benefits reduce the account value. Death benefits are expensed when
incurred, net of the account value.
Income Taxes AAG, Great American Life Insurance Company ("GALIC") and
all other 80%-owned U.S. non-life subsidiaries are consolidated with AFC
for federal income tax purposes. AAG's other life insurance
subsidiaries will file separate federal income tax returns through the
fifth year from their acquisition or formation.
AAG and GALIC have separate tax allocation agreements with AFC which
designate how tax payments are shared by members of the tax group. In
general, both companies compute taxes on a separate return basis. GALIC
is obligated to make payments to (or receive benefits from) AFC based on
taxable income without regard to temporary differences. In accordance
with terms of AAG's indentures, AAG receives GALIC's tax allocation
payments for the benefit of AAG's deductions arising from current
operations. If GALIC's taxable income (computed on a statutory
accounting basis) exceeds a current period net operating loss of AAG,
the taxes payable by GALIC associated with the excess are payable to
AFC. If the AFC tax group utilizes any of AAG's net operating losses or
deductions that originated prior to AAG's entering AFC's consolidated
tax group, AFC will pay to AAG an amount equal to the benefit received.
8
AMERICAN ANNUITY GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
Deferred income tax assets and liabilities are determined based on
differences between financial reporting and tax bases and are measured
using enacted tax rates. The Company recognizes deferred tax assets if
it is more likely than not that a benefit will be realized. Current and
deferred tax assets and liabilities of companies in AFC's consolidated
tax group are aggregated with other amounts receivable from or payable
to affiliates.
Benefit Plans AAG sponsors an Employee Stock Ownership Retirement Plan
("ESORP") covering all employees who are qualified as to age and length
of service. The ESORP, which invests primarily in securities of AAG, is
a trusteed, noncontributory plan for the benefit of the employees of AAG
and its subsidiaries. Contributions are discretionary by the directors
of AAG and are charged against earnings in the year for which they are
declared. Qualified employees having vested rights in the plan are
entitled to benefit payments at age 60.
AAG and certain of its subsidiaries provide certain benefits to eligible
retirees. The projected future cost of providing these benefits is
expensed over the period the employees earn such benefits.
Debt Issuance Costs Debt expenses are amortized over the terms of the
respective borrowings on the interest method.
Statement of Cash Flows For cash flow purposes, "investing activities"
are defined as making and collecting loans and acquiring and disposing
of debt or equity instruments and property and equipment. "Financing
activities" include annuity receipts, benefits and withdrawals and
obtaining resources from owners and providing them with a return on
their investments. All other activities are considered "operating".
Short-term investments having original maturities of three months or
less when purchased are considered to be cash equivalents for purposes
of financial statements.
C. 1995 Acquisition
In November 1995, AAG acquired all of the outstanding shares of LCC.
Its principal insurance subsidiaries were American Memorial Life
Insurance Company and Loyal American Life Insurance Company.
AAG paid approximately $106 million for the outstanding common stock of
LCC and repaid $45 million of LCC indebtedness concurrently with the
acquisition. GALIC provided approximately $90 million of the purchase
price in exchange for American Memorial and Loyal. AAG funded the
balance of the cost of acquiring LCC with the proceeds from a Common
Stock rights offering completed in August 1995, borrowings under its
line of credit, and cash on hand.
9
AMERICAN ANNUITY GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
D. Investments
The carrying value of AAG's fixed maturity portfolio was comprised of
the following at September 30, 1996:
Held to Available
Maturity for Sale Total
U. S. Government and government
agencies and authorities 0% 3% 3%
Public utilities 7 3 10
Mortgage-backed securities 12 21 33
All other corporate 26 28 54
45% 55% 100%
"Investing activities" related to fixed maturity investments in AAG's
Statement of Cash Flows for the nine months ending September 30,
consisted of the following (in millions):
Held to Available
Maturity for Sale Total
1996
Purchases ($103.9) ($655.5) ($759.4)
Maturities and paydowns 81.3 113.8 195.1
Sales 9.3 198.6 207.9
1995
Purchases ($206.9) ($536.6) ($743.5)
Maturities and paydowns 41.9 64.6 106.5
Sales 6.2 401.5 407.7
Securities classified as "held to maturity" having an amortized cost of
$9.5 million and $6.3 million were sold in the first nine months of
1996 and 1995, respectively, due to significant deterioration in the
issuers' creditworthiness.
E. Investment in Affiliate
Investment in affiliate (carrying value of $21.1 million at September
30, 1996) reflects AAG's 5% ownership (2.7 million shares) of the
common stock of Chiquita Brands International which is accounted for
under the equity method. AFG and its other subsidiaries own an
additional 38% interest in the common stock of Chiquita. Chiquita is a
leading international marketer, processor and producer of quality food
products. The market value of AAG's investment in Chiquita was
approximately $32.7 million at September 30, 1996.
F. Unamortized Insurance Acquisition Costs
Unamortized insurance acquisition costs consisted of the following (in
millions):
September 30, December 31,
1996 1995
Deferred policy acquisition costs $266.8 $228.2
Present value of future
profits acquired 68.9 73.4
Unearned revenues (153.4) (151.8)
$182.3 $149.8
10
AMERICAN ANNUITY GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
G. Notes Payable
Notes payable consisted of the following (in millions):
September 30, December 31,
1996 1995
Direct obligations of AAG:
11-1/8% Senior Subordinated Notes due
February 2003* $ 24.1 $101.4
9-1/2% Senior Notes due August 2001* 40.9 41.5
Bank Credit Line due September 1999* 74.7 20.5
Unsecured Bank Credit Line due
January 1997* 14.5 -
Other 1.2 -
Subsidiary debt 4.1 4.3
Total $159.5 $167.7
* Assumed by AAG Holding Company on November 1, 1996.
In the first three quarters of 1996, the Company repurchased $77.9
million principal amount of its Notes (including $21.3 million
purchased by GALIC) realizing a pretax extraordinary loss of
approximately $8.2 million.
AAG has a $75 million revolving credit agreement with four banks.
Loans under the credit agreement bear interest at floating rates based
on prime or Eurodollar rates and are collateralized by 25% of the
Common Stock of GALIC. In 1996, AAG obtained a $40 million unsecured
bank line of credit under terms similar to its existing credit line.
At September 30, 1996 and December 31, 1995, the weighted average rate
on the bank credit lines was 6.46% and 6.83%, respectively. The
Company expects to expand and extend its unsecured credit line.
On November 7, 1996, AAG Holding repaid $50 million of its bank lines
using proceeds from the issuance of preferred securities. (See Note K
to Consolidated Financial Statements.)
Scheduled principal payments on debt for the balance of 1996 and the
subsequent five years, adjusted to reflect the November 1996 paydowns,
are shown below (in millions). The scheduled principal payments assume
that Notes purchased are applied to the earliest scheduled retirements.
AAG Holding Other Total
1996 $ - $0.1 $ 0.1
1997 10.5 0.7 11.2
1998 - 0.7 0.7
1999 34.2 0.8 35.0
2000 - 0.8 0.8
2001 40.8 0.6 41.4
11
AMERICAN ANNUITY GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
H. Stockholders' Equity
The Company is authorized to issue 25,000,000 shares of Preferred
Stock, par value $1.00 per share.
On December 28, 1995, AAG sold 170,000 shares of newly issued
Series B Preferred Stock to an affiliate for $17 million. The
Series B Preferred Stock has a redemption value of $100 per share
and is redeemable at AAG's option. Dividends are cumulative and
payable quarterly (beginning April 1, 1996) at an annual rate of
$8.50 per share.
"Retained earnings since January 1, 1993" reflects AAG's results
since the acquisition of GALIC.
I. Contingencies
The Company is continuing its clean-up activities at certain of
its former manufacturing operations and third-party sites, in some
cases in accordance with consent agreements with federal and state
environmental agencies. Changes in regulatory standards and
further investigations could affect estimated costs in the future.
Management believes that reserves recorded are sufficient to
satisfy the known liabilities and that the ultimate cost will not,
individually, or in the aggregate, have a material adverse effect
on the financial condition or results of operations of AAG.
In 1991, the Company identified possible deficiencies in
procedures for reporting quality assurance information to the
Defense Electronics Supply Center with respect to the Company's
former manufacturing operations. Over the last several years, the
Company has been engaged in negotiations with the United States
Government with respect to the settlement of claims the Government
might have arising out of the reporting deficiencies. In March
1995, the Company received notification of additional alleged
reporting deficiencies and based on management's evaluations
additional reserves were established. The Company believes it has
sufficient reserves to cover the estimated settlement amount.
12
AMERICAN ANNUITY GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
J. Statutory Information
Insurance companies are required to file financial statements with
state insurance regulatory authorities prepared on an accounting
basis prescribed or permitted by such authorities (statutory
basis). Certain statutory amounts for GALIC were as follows (in
millions):
September 30, December 31,
1996 1995
Policyholders' surplus $277.8 $272.8
Asset valuation reserve 88.1 90.2
Interest maintenance reserve 26.7 32.2
Nine months ended September 30,
1996 1995
Net gain from operations $ 50.1 $ 44.0
Net income 48.0 42.4
The amount of dividends which can be paid by GALIC without prior
approval of regulatory authorities is subject to restrictions
relating to capital and surplus, statutory net gain from
operations and statutory net income. Based on net gain from
operations at December 31, 1995, GALIC may pay approximately $58.6
million in dividends in 1996 without prior approval, according to
the most restrictive dividend requirements of GALIC's domiciliary
states. In the first three quarters of 1996, AAG received $39.1
million in capital distributions from GALIC.
K. Subsequent Events
In connection with the anticipated establishment of a new
unsecured line of credit, the Company transferred all the
outstanding stock of GALIC to AAG Holding Company, Inc., a wholly-
owned subsidiary of the Company, on November 1, 1996. In
connection with that transaction, AAG Holding assumed all of the
Company's obligations under the 9-1/2% Senior Notes due 2001, 11-
1/8% Senior Subordinated Notes due 2003, and the bank lines of
credit. The Company has guaranteed the obligations of AAG Holding
under this indebtedness.
In November 1996, a wholly-owned trust subsidiary of AAG Holding
issued three million units of 9-1/4% Trust Originated Preferred
Securities ("TOPrS") for $75 million in cash. The Trust then
purchased $75 million of newly issued AAG Holding 9-1/4%
Subordinated Debentures due 2026, which, along with related
interest and principal payments received, will be the only assets
of the Trust. AAG Holding used the proceeds from this transaction
to retire $50 million of outstanding bank debt and the remainder
for general corporate purposes, which may include the retirement
of additional debt and investment in insurance businesses.
Holders of the TOPrS are entitled to receive quarterly cash
distributions of $0.58 per unit. Payment dates and amounts for
the TOPrS correspond to those on the Subordinated Debentures. The
TOPrS are mandatorily redeemable upon maturity or redemption of
the Subordinated Debentures. The Subordinated Debentures are
redeemable by AAG Holding on or after November 7, 2001.
Distribution and redemption payments on the TOPrS are guaranteed
by AAG Holding to the extent the Trust has funds available
therefor.
13
AMERICAN ANNUITY GROUP, INC. 10-Q
Management's Discussion and Analysis
of Financial Condition and Results of Operations
GENERAL
American Annuity Group, Inc. ("AAG" or "the Company") and AAG Holding
Company, Inc. ("AAG Holding") are organized as holding companies with nearly
all of their operations being conducted by their subsidiaries. The parent
corporations, however, have continuing expenditures for administrative
expenses, corporate services, liabilities in connection with discontinued
operations and for the payment of interest and principal on borrowings and
shareholder dividends.
Since its business is financial in nature, AAG does not prepare its
consolidated financial statements using a current-noncurrent format.
Consequently, certain traditional ratios and financial analysis tests are
not meaningful.
LIQUIDITY AND CAPITAL RESOURCES
Ratios AAG's ratio of earnings to fixed charges was 6.9 for the first nine
months of 1996 compared to 5.4 for the first nine months of 1995; the ratio
of earnings to fixed charges and preferred dividends was 6.1 for the first
nine months of 1996. The ratio of AAG's consolidated debt to equity,
excluding the effects of unrealized gains and losses on stockholders'
equity, was .42 at September 30, 1996, compared to .49 at December 31, 1995
and .79 at December 31, 1994. These same ratios including the effects of
unrealized gains and losses were .39, .39, and .90, respectively.
The National Association of Insurance Commissioners' ("NAIC") risk-based
capital ("RBC") formulas determine the amount of capital that an insurance
company needs to ensure that it has an acceptable expectation of not
becoming financially impaired. At September 30, 1996, the capital ratios of
each of AAG's insurance subsidiaries exceeded the RBC requirements by
substantial amounts.
Sources and Uses of Funds On November 7, 1996, a wholly-owned trust
subsidiary of AAG Holding raised $75 million in cash from the issuance of
preferred securities. The Company used $50 million of the proceeds to
retire bank debt; the remainder is available for general corporate purposes.
In 1994, management concluded that the Company would benefit from a
reduction in total indebtedness and the resulting reduction in debt service
requirements. The perceived benefits included (i) the ability to retain
cash to be utilized to expand the Company's operations, and (ii) the
prospect for better ratings for the Company's insurance subsidiaries. As a
result, AAG began to acquire its outstanding indebtedness, primarily through
privately negotiated transactions. In 1996 (through November 8), the
Company repurchased $57 million principal amount of its Notes for $61
million; an additional $21 million was purchased by GALIC for $23 million.
Funds for these retirements came from bank borrowings and cash on hand.
As of November 8, 1996, AAG Holding had approximately $70 million available
under its bank lines of credit. AAG Holding expects to expand and extend
its credit lines in the near future.
In September 1996, three nationally recognized rating agencies upgraded
their ratings on AAG public debentures. The senior debt is now rated
investment grade by all three agencies and the subordinated debt is rated
investment grade by two of the agencies. Additionally, two of the agencies
gave the TOPrS, issued in November 1996, an investment grade rating as well.
14
AMERICAN ANNUITY GROUP, INC. 10-Q
Management's Discussion and Analysis
of Financial Condition and Results of Operations - Continued
The November 1995 acquisition of Laurentian Capital Corporation ("LCC") was
funded primarily with internal funds supplemented by bank borrowings and the
proceeds of a common stock offering in August.
In December 1995, AAG sold $17 million of newly issued 8.5% Series B
Preferred Stock to a subsidiary of AFG. The proceeds from the sale were
contributed to GALIC. AAG expects to sell additional Preferred Stock to AFG
or its subsidiary in December 1996.
The ability of AAG and AAG Holding to pay interest and principal on debt,
dividends on preferred stock, obligations related to the Company's
discontinued manufacturing operations and other holding company costs is
dependent on payments from GALIC in the form of capital distributions and
income tax payments. In the first nine months of 1996, AAG received $55.6
million in such payments from GALIC.
The amount of capital distributions which can be paid by GALIC is subject to
restrictions relating to statutory surplus and earnings. In addition, any
dividend or distribution paid from other than earned surplus is considered
an extraordinary dividend and may be paid only after regulatory approval.
The maximum amount of dividends payable by GALIC in 1996 without prior
regulatory approval is $58.6 million.
Based upon the current level of operations and anticipated growth, AAG
believes that it will have sufficient resources to meet its liquidity
requirements.
Investments Insurance laws restrict the types and amounts of investments
which are permissible for life insurers. These restrictions are designed to
ensure the safety and liquidity of insurers' investment portfolios. The
NAIC is still considering the formulation of a model investment law. The
formulation is in the preliminary stages and management believes its impact
on AAG's operations will not be material.
The NAIC assigns quality ratings to publicly traded as well as privately
placed securities. These ratings range from Class 1 (highest quality) to
Class 6 (lowest quality). The following table shows the Company's bond
portfolio by NAIC designation (and comparable Standard & Poor's Corporation
rating) as of September 30, 1996:
NAIC % of Total
Rating Comparable S&P Rating Market Value
1 AAA, AA, A 66%
2 BBB 28
Total investment grade 94
3 BB 3
4 B 3
5 CCC, CC, C *
6 D *
Total non-investment grade 6
Total fixed maturities 100%
* less than 1%
15
AMERICAN ANNUITY GROUP, INC. 10-Q
Management's Discussion and Analysis
of Financial Condition and Results of Operations - Continued
Management believes that AAG's high quality investment portfolio should
generate a stable and predictable overall investment return.
AAG invests primarily in fixed income investments which, including loans and
short-term investments, comprised over 98% of its investment portfolio at
September 30, 1996. AAG generally invests in securities with intermediate-
term maturities with an objective of optimizing interest yields while
maintaining an appropriate relationship of maturities between AAG's assets
and expected liabilities.
At September 30, 1996, AAG had approximately $26 million in net unrealized
gains on its fixed maturity portfolio compared to net unrealized gains of
$242 million at December 31, 1995. This decrease, representing
approximately 4% of the carrying value of AAG's fixed maturity portfolio,
resulted from an increase in the general level of interest rates.
At September 30, 1996, AAG had less than 2% of total assets invested in
mortgage loans and real estate. The majority of mortgage loans and real
estate was purchased within the last three years.
At September 30, 1996, AAG's mortgage-backed securities ("MBSs") portfolio
represented approximately one-third of fixed maturity investments. As of
September 30, 1996, interest only (I/O), principal only (P/O) and other
"high risk" MBSs represented less than eight-tenths of one percent of total
assets. AAG invests primarily in MBSs which have a reduced risk of
prepayment. In addition, the majority of MBSs held by AAG were purchased at
a discount. Management believes that the structure and discounted nature of
the MBSs will minimize the effect of prepayments on earnings over the
anticipated life of the MBS portfolio.
Approximately 90% of AAG's MBSs are rated "AAA" with substantially all being
of investment grade quality. The majority are collateralized by GNMA, FNMA
and FHLMC single-family residential pass-through certificates. The market
in which these securities trade is highly liquid. Aside from interest rate
risk, AAG does not believe a material risk (relative to earnings or
liquidity) is inherent in holding such investments.
RESULTS OF OPERATIONS
General The operations of American Memorial and Loyal are included in AAG's
financial statements from the date of their acquisition in November 1995.
Accordingly, the first nine months 1996 and 1995 income statement components
are not comparable. Results of interim periods are not necessarily
indicative of future results of operations.
16
AMERICAN ANNUITY GROUP, INC. 10-Q
Management's Discussion and Analysis
of Financial Condition and Results of Operations - Continued
GALIC's principal products are Flexible Premium Deferred Annuities ("FPDAs")
and Single Premium Deferred Annuities ("SPDAs"). American Memorial offers a
variety of annuity products to finance pre-arranged funerals. The following
table summarizes AAG's annuity premiums (in millions):
Three Nine
months ended months ended
September 30, September 30,
1996 1995 1996 1995
GALIC:
FPDAs - first year $ 7 $ 9 $ 26 $ 33
FPDAs - renewal 33 37 134 145
SPDAs 81 47 223 160
121 93 383 338
American Memorial 10 - 29 -
$131 $ 93 $412 $338
The increase in GALIC's sales of SPDAs reflects the addition of two Managing
General Agencies that wrote approximately one-fifth of GALIC's total annuity
premiums for the nine months ended September 30, 1996.
Pretax Operating Earnings Pretax earnings from operations (before realized
gains) for the third quarter and first nine months of 1996 were $25.0
million and $72.1 million, respectively, compared to $18.7 million and $55.0
million for the same periods in 1995. The improvement in 1996 can be
attributed to the growth in invested assets, including the increase due to
the acquisition of American Memorial and Loyal.
Life, Accident and Health Premiums and Benefits Revenues and expenses
reflect the acquisition of American Memorial and Loyal.
Net Investment Income Net investment income increased 17% in both the third
quarter and first nine months of 1996 compared to the same periods in 1995
due to an increase in the Company's average fixed maturity investment base.
Investment income is reflected net of investment expenses of $4.9 million in
1996 and $3.8 million in 1995.
Realized Gains Individual securities are sold from time to time as market
opportunities appear to present optimal situations under AAG's investment
strategies.
Equity in Net Earnings (Losses) of Affiliate Equity in net earnings
(losses) of affiliate represents AAG's proportionate share of Chiquita's
earnings. Chiquita reported a net loss before extraordinary item for the
third quarter of 1996 and 1995 of $7.6 million and $11.0 million,
respectively. Net income before extraordinary item for the first nine
months of 1996 and 1995 was $59.7 million and $60.8 million, respectively.
Annuity Benefits Annuity benefits reflect primarily interest credited to
annuity policyholders' funds accumulated. GALIC's fixed rate annuity
products permit GALIC to change the crediting rate at any time (subject to
minimum interest rate guarantees of 3% or 4% per annum). As a result,
management has been able to react to changes in market interest rates and
maintain a desired interest rate spread
17
AMERICAN ANNUITY GROUP, INC. 10-Q
Management's Discussion and Analysis
of Financial Condition and Results of Operations - Continued
without a substantial effect on persistency. Annuity benefits increased 6%
in both the third quarter and first nine months of 1996 compared to the
respective periods in 1995 due primarily to an increase in average annuity
benefits accumulated.
Amortization of Insurance Acquisition Costs Amortization of insurance
acquisition costs increased to $21.1 million in the first nine months of
1996 from $6.2 million in the first nine months of 1995 due to the
acquisition of LCC.
Interest and Other Debt Expenses Interest on borrowings decreased 21% in
the third quarter and 15% in the first nine months of 1996 compared to the
same periods in 1995 due to repurchases of debt during 1996 and 1995, as
well as lower rates on AAG's credit facilities which were used to finance
repurchases of higher cost debt.
Other Expenses Other expenses increased in the third quarter and first nine
months of 1996 compared to the same periods in 1995 reflecting the operating
and general expenses of American Memorial and Loyal as well as additional
costs relating to expanded distribution networks.
Extraordinary Item Extraordinary item reflects AAG's losses ($5.3 million
net of tax) on retirements of its debt during the first nine months of 1996
and AAG's proportionate share of Chiquita's extraordinary loss ($0.7 million
net of tax) on the retirement of certain of its debt.
18
AMERICAN ANNUITY GROUP, INC. 10-Q
PART II
OTHER INFORMATION
ITEM 6
Exhibits and Reports on Form 8-K
(a) Exhibit 27 - Financial Data Schedule as of September 30, 1996. For
submission in electronic filing only.
(b) Report on Form 8-K - None.
Signature
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned duly authorized.
American Annuity Group, Inc.
November 13, 1996 BY:William J. Maney
Senior Vice President, Treasurer
and Chief Financial Officer
19
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